Investors still in wait-and-see mood

Market analysis - 6/17/2019

Risk assets gained further ground but trod more cautiously than in the preceding week. This is only natural as the FOMC is on June 18/19 and the G20 will take place at the end of the month. Both events will be decisive for market trends in the coming months.

Investors thus stayed in wait-and-see mode and reactions to political and economic news were muted. In the US, YoY inflation for May came in below expectations at +1.8%. Chinese data for May was also somewhat disappointing. Loan and industrial production growth fell short of expectations and imports fell. This is confirmation of a slowdown in the domestic economy and the vice prime minister said the government would underpin the economy and had the necessary fire power.

Meanwhile, the US-Mexico agreement on migrants provided some comfort even if Washington and Beijing continued to blow hot and cold on the state of trade talks.

Equity markets currently benefit from the technical support of accommodating central banks and rock-bottom interest rates. Bond yields turned lower over the week in line with falling inflation expectations. 

  European equities

The highlight this week was a rebound in cyclicals, and especially materials, after Beijing unveiled a fresh wave of infrastructure spending and adopted an accommodating tone on the renminbi. Sentiment was also helped by a comment from Arcelor-Mittal’s CFO that steel prices might have bottomed.

Markets were also lifted by news over the weekend of a $120bn mega-merger between Raytheon and United Technologies, and an agreement between the US and Mexico on migrants. Nevertheless, geopolitical tensions suddenly moved centre stage, tempering this new-found optimism, when two oil tankers were attacked in the Strait of Hormuz. Oil prices, which had started the week lower on fresh news of higher US inventories, immediately rebounded and the US dollar gained against the euro. Banks and auto stocks once again came under attack.

In an active week for corporate transformation news, Dassault Systèmes launched a $5.9bn friendly bid for Medidata Solutions in the US. The target is a cloud software specialist in the pharmaceutical field and the price tag includes its outstanding debt. This is the French group's largest-ever acquisition. Elsewhere, Salesforce is paying $15bn for Tableau Software (artificial intelligence). Volkswagen continued with preparations for the IPO of its Traton truck division. The group also announced official talks with Ford on a joint €1.5bn investment in electrical and self-driving cars. 

  US equities

US markets ended the week higher with the Nasdaq 100 up 1.26% as of the June 13 close and the S&P500 0.64% higher. Equities continued to gain on easier financial conditions following Jerome Powell’s comments in the previous week. US 10-year Treasury yields eased further, falling to 2.06%, or levels last seen in September 2017. Brent crude prices fell by close to 3% over the week to $61 on fresh fears over demand after US inventories came in higher than expected. But prices rebounded on Thursday after Washington accused Tehran of being behind two attacks on oil tankers in the Gulf of Oman

The best performing sectors over the week were consumer discretionary (+2.19%), technology (+0.64%) and telecoms (+1.0%). Natural resources also rallied (+0.97% since the beginning of the week and +10.13% since June 1) partly because of the weaker US dollar but also Beijing’s decision to spend more on infrastructure.

The worst performing sectors were industrials (-0.04%), utilities (+0.18%) and financials (+0.17%). Financials were hit by falling long rates and cautious comments from several bank CEOs on investment banking performance.

M&A deals continued apace with Salesforce bidding more than $15bn in equity for Tableau Software, the merger between Raytheon and United Technology in the defence sector, and a bid from Dassault Systèmes for Medidata Solutions (clinical trial software). 

  Japanese equities

With heightened market expectation that the Fed would cut and a favourable announcement on US trade policy, Japanese stocks tried to recover. The TOPIX edged 0.59% higher over week. Washington’s decision to call off additional tariffs on Mexican imports eased market worries on Japanese auto makers Toyota and Honda which export parts produced in Mexico to the US.

Economic sensitive sectors which had fallen bounced back, outperforming the market. Chemicals producer TORAY rose 6.42% and Electric Appliance and Precision Equipment sectors were also firm,

However, because of worries of a global slowdown from the lingering US-China trade conflict and Yen strength as US yields declined, investors appeared to focus more on domestic demand-related small cap growth stocks rather than large caps which are more exposed to external risks.  

  Emerging markets

Emerging markets ended on a positive note this week with the MSCI EM up 1.46 % as at June 13. Despite escalating trade war rhetoric, Chinese equities reacted positively to the encouraging news of more stimulus ahead. China’s slowdown persisted in May with industrial output rising 5% YoY (vs 5.4% estimated) while Jan-May fixed investment rose 5.6% YoY (vs 6.1% estimated); both came in below market consensus. China economists expect more PBoC easing in coming weeks, including cuts to interest rates or reserve ratio requirements, to counter downside risks if trade tensions were to escalate further. Export growth in China managed to beat consensus in May by growing 1% year-on-year (when the consensus was expecting a decline of 4%), while import growth fell by 9% year on year (when consensus was expecting a 4% drop). Year to date, exports have slowed to zero growth (after +10% in 2018) while imports fell to +4% year on year (vs +16% in 2018).

Interestingly, China’s exports to the US dropped 9% while those to Europe grew 7% year on year. Given the slowing European economy, we feel that China’s exports could face more downside risks if a trade deal is not reached. Chinese forex reserves rose by $6bn to $3,101bn in May, the highest reading since August 2018. Infrastructure investment also received a big boost over the week as proceeds from local government special bonds (LGSB) can now be used as equity capital for some projects, and financing from financial institutions is encouraged for projects eligible for LGSB funds. After all this stimulus spending news, it remains to be seen whether these measures will be enough to offset downward pressure on the economy. At the company level, Geely reported a 27% YoY drop in car sales and YTD sales also tumbled 12% compared to last year.  

India’s Industrial production for April rose 3.4% YoY, a 6-month high, on broad-based acceleration across sectors while infrastructure and construction spending disappointed.

Elsewhere, in another episode of the trade war saga with Mexico, President Donald Trump said he would drop plans for tariffs on Mexico that he had been threatening to impose for the past week after the country promised new steps to stem an influx of illegal migration into the U.S.

In Brazil, May’s IPCA consumer prices index came in significantly below consensus (0.20% month on month) and our expectations (0.24%). The main highlights of May’s print were food deflation; in contrast higher electricity tariffs and petrol prices were the main contributions to the upside. In the meantime, Brazil continued to move in the right direction: 1) The rapporteur presented his pension reform report at the Special Lower House Committee. Expected savings have been reduced to around $900bn (from R$ 1.2tn). The report came out earlier than expected and the reductions were smaller than expectations as well, which is good news 2) The Supreme Court ruling state owned subsidiaries can be sold without Congressional approval. This is key for President Bolsonaro’s intention of streamlining government spending by bringing in private players that can invest aggressively.

In South Africa, April retail sales beat consensus, rising 2.4% YoY vs 1.2% in the previous months and encouraging manufacturing data for the second quarter was also released.

In Argentina, the first surprise of the current political cycle took place weeks ago when former President Cristina Kirchner announced her decision to run for vice-president by appointing Alberto Fernandez as presidential candidate. The populist ‘move to the centre’ opened up the possibility of some moderate Peronist sectors joining forces by negotiating a broader opposition front. This triggered a reaction from President Macri, who is seeking re-election, and decided to put aside the Peronist/anti-Peronist axis that has shaped past political decades by expanding the Cambiemos coalition with the incorporation of Senator Pichetto as Vice Presidential candidate. 

  Commodities

After last month's incidents, two new tanker attacks occurred in the Gulf of Oman. One ship was carrying naphthalene and the other methanol. This was a step up in the US-Iran stand-off which began when the US left the May 2018 agreement on Iran's nuclear activities. Washington has since maintained intense sanctions against Iran.

Tehran has, meanwhile, given Europe 60 days or until July 7, to reach an agreement on allowing Iran to sell its oil and carry out banking transactions

Despite mounting tensions, oil prices only rose moderately when the news of the attack broke. Brent crude gained 2.8% and WTI 2.2% at the close after jumping as much as 4% earlier on. This was no doubt due to a statement from Donald Trump that he did not want war with Iran but he rekindled fears of a trade war.

Worries over demand are currently weighing on oil prices. Monthly reports from the OPEC, the IEA and the EIA all featured downward revisions in growth demand for 2019. The EIA also said global demand only grew by 200,000 b/d in the first quarter, its lowest rate since 2011. Lower demand in OECD countries, North America principally, was barely offset by developing countries. 2019 will nevertheless see a slight supply deficit due to a rebound in demand in the second half of the year. The EIA also released its first estimates for 2020. It sees demand continuing to improve, rising by 1.4% (1.4 million b/d) vs.+1.2% this year, assuming an easing in US-China tensions. Supply is expected to jump by a significant 2.3 million b/d due to production starting up in countries like Brazil, Norway and Canada as well as higher US shale oil output. This would all suggest that the next OPEC summit will decide on extending production cuts. OPEC output was estimated at 29.95 million b/d in May (down 230,000 b/d month on month). The production needed to balance out the market in 2019 is 30.2 million b/d so some slight destocking is possible. OPEC will probably only produce 29.3 million b/d in 2020, its lowest tally since 2003. 

  Corporate debt

 

Credit

Markets initially rose on accommodating central bank statements and the US-Mexico migrant agreement but fresh US-China tensions subsequently weighed on spreads. The Xover tightened by 6bp between Monday and Thursday and the Main by 1bp.

Tereos reported a disappointing 54% slump in EBITDA due to sugar price falls in 2018. Net debt also rose and leverage hit 9.1 times. However, the group said it was selling assets to Italy’s ETEA to help with deleveraging.

Loxam launched a €970m bid on Finland’s Ramirent in a move to become Europe’s largest equipment leasing group. The deal will be funded by a bridging loan which will increase leverage. The group has still not completed efforts to deleverage since it acquired Lavendon in 2017 and the news sent Loxam's bonds lower. Thomas Cook rose sharply at the beginning of the week after news over a possible sale of its tour operating businesses to Fosun. But some of the gains were wiped out after press reports that a significant amount of the bank debt would be put up for sale. Spain’s Aldesa’s bonds gained 6 points, outperforming the market, after Santander agreed to extend the construction group’s credit lines from May 2020 to January 2021.

ING said it was no longer interested in buying Commerzbank. This tallies with the previous week’s comments from executive management that transborder mergers before a Banking Union is up and running would only be of marginal interest.

In a busy week on the primary market, Spie raised €600m over 7 years at 2.625%, partly to refinance its 2023 term loan. IGT raised €750m over 7 years at 3.5% and saw strong demand. The financial sector saw a number of Senior and Senior Non Preferred deals from Caixabank, BBVA, Santander, and UBI Banca. Lloyds easily raised $500m with an AT1 at 6.75%. 

Convertibles 

There were two new convertible issues in the US and one China/Europe exchangeable deal. Add in a $1.4bn mandatory convertible (increased from $1.25bn due to strong demand) from gas and electricity producer and distributor Dominion Energy, and a total of $2.9bn was raised over the week.

Vonage (VoIP), which is moving from a consumer to company-based model, raised $300m over 5 years at 1.75% and with a 42.5% premium. The proceeds will go on repaying more expensive debt.

Zynga (on-line games) raised $690m, including a $90m greenshoe, at 0.25% and with a 32.5% premium. $100m will be used to reimburse existing debt and the rest on any future acquisitions.

Geely Sweden (financial services with Zhejiang Geely Holding as its parent company) sold a €400m bond exchangeable into Volvo AB (a global leader in HGV, bus and boat engine construction). The bond has a 5-year maturity, a zero coupon and a 25% conversion premium.

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